Monday, November 16, 2009

The minimum wage went up to $7.25 an hour on July 24th as the last of a three year planned increase passed by Congress. The increase is $.70 an hour over the minimum in 2008, a 10.7 percent increase. Since inflation is reported at 3.8 percent for the year the buying power of the minimum wage went up for 2009.

Despite three years of increase, the Federal minimum wage has a history of falling buying power. During the years 1997 to 2007 the federal minimum wage was frozen at $5.15 per hour. Even with annual inflation in the one to three percent range the minimum wage lost 25 percent of its buying power. A wage of $5.15 an hour in 2007 would only buy what $3.99 would buy in 1997.

The Bureau of Labor Statistics publishes wage ranges by occupation as part of its occupational employment survey. The median wage is often quoted in the popular press but there are wage ranges published that include the 10th, 25th, 75th and 90th percentile wages by occupation. For example, the 2008 data show 3.5 million employed nationwide as cashiers with a 10th percentile wage of $6.88. That means that 10 percent, or 350 thousand jobs, can be expected to have wages equal to or less than $6.88 an hour.

The 2008 data show cashier and 30 other occupations with 18 million jobs that have 10th percentile wages of $7.25 or less, which means 1.8 million of the total can expect a boost in pay. It is a $1,456.00 annual increase over the old minimum for a full time job, but still only $15,080 a year and barely half of a self supporting wage.

Business tends to oppose any increase in the minimum wage and economists predict in sinister tones that higher minimum wages lead to falling employment, hurting those who expect to be helped. However, the tendency to use less labor at higher wages is universal and not confined to just minimum wage jobs.

For example, the Bureau of Labor Statistics reports managerial jobs in decline with a drop from just over 8 million in 1999 to barely 6 million in 2008. Engineering managers are down by nearly 70 thousand as median wages went steadily up reaching $115,000 in 2008.

Economizing on high paid engineering managers puts engineers in surplus as long as we expect former engineering managers to be looking for engineering work in occupations related to engineering. Most engineering specialties like civil engineering and mechanical engineering have median wages in the mid $70’s. Engineering technician jobs have median wages in the $40’s.

Civil and mechanical engineering jobs are up with some of the unemployed engineering managers adding to the supply of labor, but we can’t be sure who got the engineering jobs. If it is former engineering managers it will certainly mean a pay cut for them.

It could be an engineer who was working as a lower paid engineering technician. If that is the case it will mean a pay raise for them, but it could also be a college graduate in engineering who had been working in a minimum wage job. If that is the case it will mean a pay raise for them.

During the years from 2006 to the present when the minimum wage jumped by $2.10 an hour, jobs as fast food cooks dropped from over 600 thousand to 559 thousand. Maybe that is due to the higher minimum wage, but during the same period there were other labor markets where a surplus of labor kept wages lower and helped expand employment, but in wage ranges well above the minimum.

Economists tend to ignore what is happening in high wage job markets when they predict changes for markets with the lowest wage. A higher minimum wage can eliminate low wage jobs, but that does not relegate the people who had them to endless unemployment, nor prevent them from getting higher wage jobs. That is because changes in job markets create surplus labor in many occupations in other wage ranges, both high and low.

Families are a second wage issue that economists tend to ignore. Economists act as though individuals make independent decisions when it is time to enter the labor force and become part of the labor supply. Yet a majority of Americans live in families and make job decisions that depend on their spouse and the circumstance of other family members.

Suppose the mister in the Smith family has a job as a tool and die maker working in manufacturing and his wife works part time in retail. Tool and die maker is one of America’s better paid production occupations with a median wage reported at $22.32 an hour or $46,430 a year for 2008, and a 90th percentile wage of $34.76 an hour or $72,300 a year. Together they might earn $60 to $80 thousand dollars.

The Bureau of Labor Statistics reports jobs as tool and die maker in decline every year since the late 1990’s. With a broad base of manufacturing also in decline it is easy to imagine a layoff for Mr. Smith. Economists argue and predict people will work less at lower wages and work more at higher wages so unless Mr. Smith can find work at his tool and die maker wage economists expect him to work less after a layoff than before.

Economists do not base their predictions on interviews, observation or data. Instead they rely on conjecture about preferences. Leisure they argue is valuable and will be traded for work in the personal preferences of individuals. Therefore, at higher wages leisure is more expensive because it means giving up those higher wages, and people with standard preferences want less of what is more expensive. Conversely, at lower wages leisure is less expensive because it means giving up lower wages, and people will want more leisure because it’s less expensive.

Those less devoted to the economist’s way think the Smith’s will do whatever they can to pay the bills and maintain their economic status. Mr. Smith will take a job in maintenance or construction or whatever he can find at lower wages if necessary, and a second job working evenings or weekends. Mrs. Smith will work more hours in retail. Together the Smith’s work more hours at lower wages to keep up, just as they might work less if their wage was higher. People like the Smiths assure that lower wages add to the surplus of labor.

It is easy to understand the business opposition to the minimum wage: it converts profits to costs at $1,456 dollars per full time minimum wage employee. The economist’s opposition to a higher minimum wage is different; they argue that forcing up wages is bad for labor by reducing jobs and raising unemployment as more people look for work at the higher wage.

Economists ignore the two possibilities mentioned above: that those who lose low wage jobs can find surplus markets and other jobs at higher wages and that families work more at lower wages. If either is true then economists are giving bad advice.

This July 24th Secretary of Labor Hilda L. Solis announced “This administration is committed to improving the lives of working families across the nation, and the increase in the minimum wage is another important step in the right direction. This well-deserved increase will help workers better provide for their families in the face of today's economic challenges.”

Politicians often exaggerate the significance of what they do and it does sound like high praise for a wage of $7.25 an hour. It is not enough increase to be the important step she says, but it is in the right direction.

Sunday, November 8, 2009

Banks are essential, but troublesome institutions that keep checking accounts for depositors, but only hold a fraction of deposit liabilities in reserve to pay for checks.

Normally 15 cents on the dollar will be adequate reserves because those writing checks will about equal those making deposits. Normally borrowers will be paying principal and interest to further assure that banks have reserves to pay on their checking accounts.

Because a bank’s liabilities include personal and business checking accounts, i.e. money, the larger society has a special need to regulate banks to make sure they have reserves to meet their account liabilities.

Even though bank regulations requiring minimum reserves have been around a long time banks have been left to decide which loans to make and which loans to refuse. Individual banks decided when to make loans to hedge funds and how much to loan.

To make payments on their loans hedge fund managers need to have their own reserve funds from investors, or profits, but hedge funds are unregulated so it is up to hedge fund managers to decide their reserves.

More than a few people urge that hedge funds should be regulated like banks because they are taking risks more risky than banks, which can bring down the financial system.

To judge the risk yourself suppose it is 1993 and you are the manager at Long Term Capital Management, a new hedge fund. You notice in August that a new 30 year Treasury bond with coupon interest of 7.2 percent starts trading at 7.24 percent interest and a price of $980.84 for a $1,000 bond, but another 30 year Treasury bond first sold in February 1993 is trading for 7.36 percent interest at a price of $995.13. (Price calculations are from MS Excel function PRICE)

To exploit the difference of price, the spread, you get a loan to buy the cheaper and older $1,000 bond at $980.84. Then you borrow the other bond from a brokerage house like Merrill-Lynch and immediately sell it for $995.13 cash.

The two transactions will be profitable if the interest rates converge over time: the low one rises and the high one falls. Economic theory predicts price differences will be temporary for a product or service; low prices rise and high prices fall until all are equal.

Suppose in two months the interest rates do converge to 7.3 percent.

At 7.3 percent interest you can sell the older bond for $987.83: a $6.99 profit. You buy back the newer bond for $987.77 and return it to Merrill-Lynch. Since you sold it for $995.13 you make $7.36 on the second transaction. Total profit equals $14.35.Earning $14.35 will not make you rich, but if a bank will lend you $1 billion to buy many bonds and interest rates do converge then you can get rich.

Banks made billions in loans to hedge funds and many made profits doing the same and similar transactions as the one above. Eventually though, interest rates diverged and some countries and companies defaulted on the bonds in hedge fund portfolios.

Hedge funds could only sell their bonds at a loss, if at all, and without reserves or cash they defaulted on billions in loans. Banks needed those loan payments to have enough reserves to clear checking accounts: my money and yours. That was the downward spiral, the crisis.

Sunday, November 1, 2009

Automobiles have a unique place in American consumption and personal finance. Nothing else remains our personal choice that costs so much and depreciates so fast.

As everyone knows cars are more than transportation. For people in business it is often important to have a late model car to project an image of prestige and prosperity. Others are interested in style and performance and buy one car over another for a range of personal reasons.

For those who buy cars to minimize their personal expense, they buy a used car. Automobile companies, dealers and car traders have to publish price and sales information to do their business, which makes it possible to follow depreciation from the manufacturers suggested retail price through years of resale.

Used car buyers know the first rule of used cars: age lowers used car prices faster than mileage. They also know mileage lowers the value of a car more than age. Take an example like the Toyota Camry Sedan. In 1999 a new Camry had a manufacturers suggested retail price of $21,888. This spring, 10 years later, various sales guides show a used car price around $6,400, which is depreciation of almost $15,500, or roughly 71 percent depreciation.

A buyer getting a 10 year old Camry for $6,400 pays 29 percent of the original manufacturers suggested retail price so here is a good question to ask yourself: Can I get more than 29 percent of the car’s total mileage? A 10 year old Camry in decent shape that passes state inspections and with less than 100 thousand miles almost certainly has more than half its usable miles.

Cars last longer and break down less than they used to do, both foreign and domestic. In spite of higher quality, resale prices still drop much faster by age than by miles. As long as that is true used car buyers can capture more of the benefits of higher quality by driving the last miles of a car rather than the first.

Remember as well that a used car means additional savings because the lower price lets you earn interest on the money you saved, or avoid interest on the money you did not need to borrow.

I have checked other makes and models and when I compare reported used car prices of 10 year old cars as a ratio to the manufacturers suggested retail price I find the ratio stays in the low 70 percent range. For the Honda Accord it was 70 percent, the Acura and the Maxima 76 percent, the Mustang 69 percent. Even a Ford, Crown Victoria turned out to be 76 percent.

I often hear people say they buy a foreign car over a domestic car because it retains its value longer. Mine is a small sample but if many other makes and models also lose 70 to 76 percent of their value in 10 years, then cars lose value at about the same rate, suggesting quality is more the same than many of us believe.

Find yourself a 10 year old car; keep it under 100 thousand miles; pay as much less than 70 percent of the manufacturer’s suggested retail price as you can negotiate and save a bundle.